Emissions trading or cap and trade is a market-based
approach used to control pollution
by providing economic incentives
for achieving reductions in the emissions of pollutants.
A central authority (usually a governmental
body) sets a limit or cap on the amount of a pollutant that may be
emitted. The limit or cap is allocated or sold to firms in the form of
emissions permits which represent the right to emit or discharge a specific
volume of the specified pollutant. Firms are required to hold a number of
permits (or allowances or carbon
credits) equivalent to their emissions. The total number of
permits cannot exceed the cap, limiting total emissions to that level. Firms
that need to increase their volume of emissions must buy permits from those who
require fewer permits.
The transfer of permits is referred to as a trade.
In effect, the buyer is paying a charge for polluting, while the seller is
being rewarded for having reduced emissions. Thus, in theory, those who can
reduce emissions most cheaply will do so, achieving the pollution reduction at
the lowest cost to society.
There are active trading programs in several air
pollutants. For greenhouse
gases the largest is the European Union Emission
Trading Scheme, whose purpose is to avoid dangerous climate change.
In the United States there is a national
market to reduce acid rain
and several regional markets in nitrogen oxides.
Markets for other pollutants tend to be smaller and more localized.
Pollution as an externality
By definition, an externality
is an activity of one entity that affects the welfare of another entity in a
way that is outside the market mechanism. Pollution
is the prime example most economists think of when discussing externalities.
There are many different ways to address these from a public economics
perspective including emissions fees, cap-and-trade, and command and control regulation.
Here we will discuss cap-and-trade as the chosen public response to
externalities.
Overview
The overall goal of an emissions trading plan is to
minimize the cost of meeting a set emissions target or cap. The cap is an
enforceable limit on emissions that is usually lowered over time—aiming towards
a national emissions reduction target. In some systems, a proportion of all
traded permits must be retired periodically, causing a net reduction in
emissions over time. In many cap-and-trade systems, organizations which do not
pollute (and therefore have no obligations) may also participate in trading.
Thus environmental groups may purchase
and retire emission permits and hence drive up the price of the remaining
permits according to the law
of demand. Corporations can also prematurely retire allowances by
donating them to a nonprofit entity and then be eligible for a tax deduction.
Definitions
The economics literature provides the following
definitions of cap and trade emissions trading schemes.
A cap-and-trade system constrains the aggregate
emissions of regulated sources by creating a limited number of tradable
emission allowances, which emission sources must secure and surrender in number
equal to their emissions.
In an emissions trading or cap-and-trade scheme, a
limit on access to a resource (the cap) is defined and then allocated among
users in the form of permits. Compliance is established by comparing actual
emissions with permits surrendered including any permits traded within the cap.
Under a tradable permit system, an allowable
overall level of pollution is established and allocated among firms in the form
of permits. Firms that keep their emission levels below their allotted level
may sell their surplus permits to other firms or use them to offset excess
emissions in other parts of their facilities.
Market-based and least-cost
Economy-wide pricing of carbon is the centre piece of
any policy designed to reduce emissions at the lowest possible costs.
Ross Garnaut, lead author of the Garnaut Climate Change Review
Economists have urged the use of
"market-based" instruments such as emissions trading to address
environmental problems instead of prescriptive "command and control"
regulation. Command and control regulation is criticized for being excessively
rigid, insensitive to geographical and technological differences, and
inefficient. However, emissions trading requires a cap to effectively reduce
emissions, and the cap is a government regulatory mechanism. After a cap has
been set by a government political process, individual companies are free to
choose how or if they will reduce their emissions. Failure to report emissions
and surrender emission permits is often punishable by a further government
regulatory mechanism, such as a fine that increases costs of production. Firms
will choose the least-cost way to comply with the pollution regulation, which
will lead to reductions where the least expensive solutions exist, while
allowing emissions that are more expensive to reduce.
Emission markets
For emissions trading where greenhouse gases are
regulated, one emissions permit or allowance is considered equivalent to one metric ton
of carbon dioxide (CO2)
emissions. Other names for emissions permits are carbon
credits, Kyoto units, assigned amount units, and Certified Emission Reduction
units (CER). These permits or units can be sold privately or in the
international market at the prevailing market price. These trade and settle internationally and hence
allow allowances to be transferred between countries. Each international
transfer is validated by the United Nations
Framework Convention on Climate Change (UNFCCC). Each transfer of
ownership within the European
Union is additionally validated by the European Commission.
Trading exchanges have been established to provide a spot
market in permits, as well as futures
and options market
to help discover a market price and maintain liquidity.
Carbon prices are normally quoted in euros per
tonne of carbon dioxide or its equivalent (CO2e). Other greenhouse
gases can also be traded, but are quoted as standard multiples of carbon
dioxide with respect to their global warming potential.
These features reduce the quota's financial impact on business, while ensuring
that the quotas are met at a national and international level.
Currently there are six exchanges trading in UNFCCC
related carbon credits: the Chicago Climate Exchange
(until 2010), European Climate Exchange, NASDAQ OMX Commodities Europe,
PowerNext,
Commodity Exchange Bratislava
and the European Energy Exchange.
NASDAQ OMX Commodities Europe listed a contract to trade offsets generated by a
CDM carbon project called Certified
Emission Reductions. Many companies now engage in emissions abatement,
offsetting, and sequestration programs to generate credits that can be sold on
one of the exchanges. At least one private electronic market
has been established in 2008: CantorCO2e. Carbon credits at Commodity Exchange
Bratislava are traded at special platform - Carbon place.
Trading in emission permits is one of the
fastest-growing segments in financial services in the City
of London with a market estimated to be worth about €30 billion
in 2007. Louis Redshaw, head of environmental markets at Barclays
Capital, predicts that "Carbon will be the world's biggest
commodity market, and it could become the world's biggest market overall."
History
The efficiency of what later was to be called the
"cap-and-trade" approach to air
pollution abatement was first demonstrated in a series of
micro-economic computer simulation studies between 1967 and 1970 for the
National Air Pollution Control Administration (predecessor to the United States
Environmental Protection Agency's Office of Air and Radiation) by
Ellison Burton and William Sanjour. These studies used mathematical models of
several cities and their emission sources in order to compare the cost and
effectiveness of various control strategies. Each abatement strategy was
compared with the "least cost solution" produced by a computer
optimization program to identify the least costly combination of source
reductions in order to achieve a given abatement goal. In each case it was
found that the least cost solution was dramatically less costly than the same
amount of pollution reduction produced by any conventional abatement strategy.
Burton and later Sanjour along with Edward H. Pechan continued improving and advancing these computer models at the
newly created U.S. Environmental Protection Agency. The agency introduced the
concept of computer modeling with least cost abatement strategies (i.e. emissions
trading) in its 1972 annual report to Congress on the cost of clean air.This
led to the concept of "cap and trade" as a means of achieving the
"least cost solution" for a given level of abatement.
The development of emissions trading over the course
of its history can be divided into four phases:
- Gestation: Theoretical articulation of the instrument (by Coase, Crocker, Dales, Montgomery etc.) and, independent of the former, tinkering with "flexible regulation" at the US Environmental Protection Agency.
- Proof of Principle: First developments towards trading of emission certificates based on the "offset-mechanism" taken up in Clean Air Act in 1977.
- Prototype: Launching of a first "cap-and-trade" system as part of the US Acid Rain Program in Title IV of the 1990 Clean Air Act, officially announced as a paradigm shift in environmental policy, as prepared by "Project 88", a network-building effort to bring together environmental and industrial interests in the US.
- Regime formation: branching out from the US clean air policy to global climate policy, and from there to the European Union, along with the expectation of an emerging global carbon market and the formation of the "carbon industry".
In the United States, the "acid
rain"-related emission trading system was principally conceived by C.
Boyden Gray, a G.H.W.
Bush administration attorney. Gray worked with the Environmental
Defense Fund (EDF), who worked with the EPA to write the bill that became law
as part of the Clean Air Act of 1990. The new emissions cap on NOx
and SO2 gases took effect in 1995, and according to Smithsonian magazine,
those acid rain emissions dropped 3 million tons that year.
Public opinion
In the United States, most polling shows large support
for emissions trading (often referred to as cap-and-trade). This majority
support can be seen in polls conducted by Washington
Post/ABC News, Zogby International[33]
and Yale University.
According to PolitiFact,
it is a misconception that emissions trading is unpopular in the United States
because of earlier polls from Zogby International and Rasmussen
which misleadingly include "new taxes" in the questions (taxes aren't
part of emissions trading) or high energy cost estimates.
Comparison of cap and trade with other methods of
emission reduction
Cap and trade, offsets created through a baseline and
credit approach, and a carbon tax are all market-based approaches that put a price
on carbon and other greenhouse gases, and provide an economic
incentive to reduce emissions, beginning with the lowest-cost opportunities.
The textbook emissions trading program can be called a
"cap and trade" approach in which an aggregate cap on all sources is
established and these sources are then allowed to trade emissions permits
amongst themselves to determine which sources actually emit the total pollution
load. An alternative approach with important differences is a baseline and
credit program.
In a baseline and credit program polluters that are
not under an aggregate cap can create permits or credits, usually called
offsets, by reducing their emissions below a baseline level of emissions. Such
credits can be purchased by polluters that have a regulatory limit.
Cap and trade versus carbon tax and other methods
Cap and trade versus carbon tax
Regulation by cap-and-trade emissions trading can be
compared to emissions fees or environmental tax approaches under a number of
possible criteria.
Responsiveness to inflation: In the case of inflation,
cap-and-trade is at an advantage over emissions fees because it adjusts to the
new prices automatically and no legislative or regulatory action is needed.
Responsiveness to cost changes: It is difficult to
tell which is better between cap-and-trade and emissions fees; therefore, it
might be a better option to combine the two resulting in the creation of a
safety valve price (a price set by the government at which polluters can
purchase additional permits beyond the cap).
Responsiveness to recessions: This point is closely
related to responsiveness to cost changes, because recessions cause a drop in
demand. Under cap and trade, the emissions cost automatically decreases, so a
cap-and-trade scheme adds another automatic stabilizer to the
economy - in effect, a type of automatic fiscal stimulus. However, if the
emissions price drops to a low level, efforts to reduce emissions will also be
reduced. Assuming that a government is competently able to stimulate the
economy regardless of the cap-and-trade scheme, an excessively low price
represents a missed opportunity to cut emissions faster than planned, so adding
a price floor (or equivalently, switching to a tax temporarily) might be better
- especially when there is great urgency about cutting emissions, as with
greenhouse gas emissions. A price floor would also provide a degree of
certainty and stability for investment in emissions reductions: recent
experiences from the UK have shown that nuclear power operators are reluctant
to invest on "un-subsidised" terms unless there is a guaranteed price
floor for carbon (which the EU emissions trading scheme does not presently
provide).
Responsiveness to uncertainty: As with cost changes,
in a world of uncertainty, it is not clear whether emissions fees or
cap-and-trade systems are more efficient—it basically depends on how fast the
marginal social benefits of reducing pollution fall with the amount of cleanup
(e.g., whether inelastic or elastic marginal social benefit schedule).
Cap-and-trade versus command-and-control regulation
Unlike emissions fees and cap and trade, which are
incentive-based regulations, command-and-control regulations take a variety of
forms and are much less flexible. An example of this is a performance standard
which sets an emissions goal for each polluter that is fixed and, therefore,
the burden of reducing pollution cannot be shifted to the firms that can
achieve it more cheaply. As a result, performance standards are unlikely to be
as cost effective as cap-and-trade emissions trading. Firms would charge for a
higher cost for a product and a proportion of such higher cost will be passed
through to the end consumers.
Economics of international emissions trading
It is possible for a country to reduce emissions using
a Command-Control
approach, such as regulation, direct
and indirect taxes. The cost of that approach
differs between countries because the Marginal Abatement Cost Curve
(MAC) — the cost of eliminating an additional unit of pollution —
differs by country. It might cost China $2 to eliminate a ton of CO2,
but it would probably cost Norway or the U.S. much more. International
emissions-trading markets were created precisely to exploit differing MACs.
Example
Emissions trading through Gains from Trade can
be more beneficial for both the buyer and the seller than a simple emissions
capping scheme.
Consider two European countries, such as Germany and
Sweden. Each can either reduce all the required amount of emissions by itself
or it can choose to buy or sell in the market.
Example MACs for two different countries
For this example let us assume that Germany can abate
its CO2 at a much cheaper cost than Sweden, i.e. MACS
> MACG where the MAC curve of Sweden is steeper (higher slope)
than that of Germany, and RReq is the total amount of emissions that
need to be reduced by a country.
On the left side of the graph is the MAC curve for
Germany. RReq is the amount of required reductions for Germany, but
at RReq the MACG curve has not intersected the market
emissions permit price of CO2 (market permit price = P = λ). Thus,
given the market price of CO2 allowances, Germany has potential to
profit if it abates more emissions than required.
On the right side is the MAC curve for Sweden. RReq
is the amount of required reductions for Sweden, but the MACS curve
already intersects the market price of CO2 permits before RReq
has been reached. Thus, given the market price of CO2 permits,
Sweden has potential to make a cost saving if it abates fewer emissions than
required internally, and instead abates them elsewhere.
In this example, Sweden would abate emissions until
its MACS intersects with P (at R*), but this would only reduce a
fraction of Sweden's total required abatement.
After that it could buy emissions credits from Germany
for the price P (per unit). The internal cost of Sweden's own abatement,
combined with the permits it buys in the market from Germany, adds up to the
total required reductions (RReq) for Sweden. Thus Sweden can make a
saving from buying permits in the market (Δ d-e-f). This represents the
"Gains from Trade", the amount of additional expense that Sweden
would otherwise have to spend if it abated all of its required emissions by
itself without trading.
Germany made a profit on its additional emissions
abatement, above what was required: it met the regulations by abating all of
the emissions that was required of it (RReq). Additionally, Germany
sold its surplus permits to Sweden, and was paid P for every unit it
abated, while spending less than P. Its total revenue is the area of the
graph (RReq 1 2 R*), its total abatement cost is area (RReq
3 2 R*), and so its net benefit from selling emission permits is the area (Δ
1-2-3) i.e. Gains from Trade
The two R* (on both graphs) represent the efficient
allocations that arise from trading.
- Germany: sold (R* - RReq) emission permits to Sweden at a unit price P.
- Sweden bought emission permits from Germany at a unit price P.
If the total cost for reducing a particular amount of
emissions in the Command Control scenario is called X, then to
reduce the same amount of combined pollution in Sweden and Germany, the total
abatement cost would be less in the Emissions Trading scenario i.e.
(X — Δ 123 - Δ def).
The example above applies not just at the national
level: it applies just as well between two companies in different countries, or
between two subsidiaries within the same company.
Applying the economic theory
The nature of the pollutant plays a very important
role when policy-makers decide which framework should be used to control
pollution.
CO2 acts globally, thus its impact on the
environment is generally similar wherever in the globe it is released. So the
location of the originator of the emissions does not really matter from an
environmental standpoint.
The policy framework should be different for regional
pollutants (e.g. SO2
and NOx,
and also mercury) because the impact exerted
by these pollutants may not be the same in all locations. The same amount of a
regional pollutant can exert a very high impact in some locations and a low
impact in other locations, so it does actually matter where the pollutant is
released. This is known as the Hot Spot problem.
A Lagrange framework is commonly
used to determine the least cost of achieving an objective, in this case the
total reduction in emissions required in a year. In some cases it is possible
to use the Lagrange optimization framework to determine the required reductions
for each country (based on their MAC) so that the total cost of reduction is
minimized. In such a scenario, the Lagrange multiplier represents the
market allowance price (P) of a pollutant, such as the current market price of
emission permits in Europe and the USA.
Countries face the permit market price that exists in
the market that day, so they are able to make individual decisions that would
minimize their costs while at the same time achieving regulatory compliance.
This is also another version of the Equi-Marginal
Principle, commonly used in economics to choose the most
economically efficient decision.
Prices versus quantities, and the safety valve
There has been longstanding debate on the relative
merits of price versus quantity instruments to achieve emission
reductions.
An emission cap and permit trading system is a quantity
instrument because it fixes the overall emission level (quantity) and allows
the price to vary. Uncertainty in future supply and demand conditions (market
volatility) coupled with a fixed number of pollution permits creates an
uncertainty in the future price of pollution permits, and the industry must
accordingly bear the cost of adapting to these volatile market conditions. The
burden of a volatile market thus lies with the industry rather than the
controlling agency, which is generally more efficient. However, under volatile
market conditions, the ability of the controlling agency to alter the caps will
translate into an ability to pick "winners and losers" and thus
presents an opportunity for corruption.
In contrast, an emission
tax is a price instrument because it fixes the price while
the emission level is allowed to vary according to economic activity. A major
drawback of an emission tax is that the environmental outcome (e.g. a limit on
the amount of emissions) is not guaranteed. On one hand, a tax will remove
capital from the industry, suppressing possibly useful economic activity, but
conversely, the polluter will not need to hedge as much against future
uncertainty since the amount of tax will track with profits. The burden of a
volatile market will be borne by the controlling (taxing) agency rather than
the industry itself, which is generally less efficient. An advantage is that,
given a uniform tax rate and a volatile market, the taxing entity will not be
in a position to pick "winners and losers" and the opportunity for
corruption will be less.
Assuming no corruption and assuming that the
controlling agency and the industry are equally efficient at adapting to
volatile market conditions, the best choice depends on the sensitivity of the
costs of emission reduction, compared to the sensitivity of the benefits (i.e.,
climate damage avoided by a reduction) when the level of emission control is
varied.
Because there is high uncertainty in the compliance
costs of firms, some argue that the optimum choice is the price mechanism.
However, the burden of uncertainty cannot be eliminated, and in this case it is
shifted to the taxing agency itself.
Some scientists have warned of a threshold in
atmospheric concentrations of carbon dioxide beyond which a run-away warming
effect could take place, with a large possibility of causing irreversible
damage. If this is a conceivable risk then a quantity instrument could be a
better choice because the quantity of emissions may be capped with a higher
degree of certainty. However, this may not be true if this risk exists but
cannot be attached to a known level of greenhouse gas (GHG) concentration or a
known emission pathway.
A third option, known as a safety valve, is a
hybrid of the price and quantity instruments. The system is essentially an
emission cap and permit trading system but the maximum (or minimum) permit
price is capped. Emitters have the choice of either obtaining permits in the
marketplace or purchasing them from the government at a specified trigger price
(which could be adjusted over time). The system is sometimes recommended as a
way of overcoming the fundamental disadvantages of both systems by giving
governments the flexibility to adjust the system as new information comes to
light. It can be shown that by setting the trigger price high enough, or the
number of permits low enough, the safety valve can be used to mimic either a
pure quantity or pure price mechanism.
All three methods are being used as policy instruments
to control greenhouse gas emissions: the EU-ETS is a quantity system using
the cap and trading system to meet targets set by National Allocation Plans;
Denmark has a price system using a carbon tax
(World Bank, 2010, p. 218), while China uses the CO2 market
price for funding of its Clean Development Mechanism
projects, but imposes a safety valve of a minimum price per tonne of CO2.
Carbon leakage
Carbon leakage is the effect that
regulation of emissions in one country/sector has on the emissions in other
countries/sectors that are not subject to the same regulation (Barker et al.,
2007). There is no consensus over the magnitude of long-term carbon leakage
(Goldemberg et al., 1996, p. 31).
In the Kyoto Protocol, Annex I countries are subject
to caps on emissions, but non-Annex I countries are not. Barker et al..
(2007) assessed the literature on leakage. The leakage rate is defined as the
increase in CO2 emissions outside of the countries taking domestic
mitigation action, divided by the reduction in emissions of countries taking
domestic mitigation action. Accordingly, a leakage rate greater than 100% would
mean that domestic actions to reduce emissions had had the effect of increasing
emissions in other countries to a greater extent, i.e., domestic mitigation
action had actually led to an increase in global emissions.
Estimates of leakage rates for action under the Kyoto
Protocol ranged from 5 to 20% as a result of a loss in price competitiveness,
but these leakage rates were viewed as being very uncertain. For
energy-intensive industries, the beneficial effects of Annex I actions through
technological development were viewed as possibly being substantial. This
beneficial effect, however, had not been reliably quantified. On the empirical
evidence they assessed, Barker et al. (2007) concluded that the
competitive losses of then-current mitigation actions, e.g., the EU ETS, were
not significant.
Under the EU ETS rules Carbon
Leakage Exposure Factor is used to determine the volumes of free
allocation of emission permits to industrial installations.
Trade
One of the controversies about carbon mitigation
policy thus arises about how to "level the playing field" with border
adjustments. One component of the American Clean Energy and
Security Act, for example, along with several other energy bills
put before Congress, calls for carbon surcharges on goods imported from
countries without cap-and-trade programs. Even aside from issues of compliance
with the General Agreement on Tariffs
and Trade, such border adjustments presume that the producing
countries bear responsibility for the carbon emissions.
A general perception among developing countries is
that discussion of climate change in trade negotiations could lead to
"green protectionism" by high-income
countries (World Bank, 2010, p. 251). Tariffs on imports ("virtual
carbon") consistent with a carbon price of $50 per ton of CO2
could be significant for developing countries. World Bank (2010) commented that
introducing border tariffs could lead to a proliferation of trade measures
where the competitive playing field is viewed as being uneven. Tariffs could
also be a burden on low-income countries that have contributed very little to
the problem of climate change.
Trading systems
Kyoto Protocol
As the Intergovernmental Panel on
Climate Change (IPCC) reports came in over the years, they shed
abundant light on the true state of global warming and they gave support to the
environmental effort to address this unprecedented problem. However, the same
discussions that started decades back had never ceased and the crusade for a
tangible solution to global climate change had gone on all the while. In 1997
the Kyoto Protocol was adopted. The Kyoto
Protocol is a 1997 international treaty that came into force in
2005. In the treaty, most developed nations agreed to legally binding targets
for their emissions of the six major greenhouse
gases. Emission quotas (known as "Assigned amounts")
were agreed by each participating 'Annex I' country, with the intention of
reducing the overall emissions by 5.2% from their 1990 levels by the end of
2012. The United States is the only industrialized nation under Annex I
that has not ratified the treaty, and is therefore not bound by it. The IPCC
has projected that the financial effect of compliance through trading within
the Kyoto commitment period will be limited at between 0.1-1.1% of GDP among
trading countries.
The Protocol defines several mechanisms ("flexible mechanisms") that
are designed to allow Annex I countries to meet their emission reduction
commitments (caps) with reduced economic impact (IPCC, 2007).
Under Article 3.3 of the Kyoto Protocol, Annex I
Parties may use GHG removals, from afforestation and reforestation (forest
sinks) and deforestation (sources) since 1990, to meet their emission reduction
commitments.
Annex I Parties may also use International Emissions
Trading (IET). Under the treaty, for the 5-year compliance period from 2008
until 2012, nations that emit less than their quota will be able to sell assigned amount units to nations
that exceed their quotas. It is also possible for Annex I countries to sponsor carbon
projects that reduce greenhouse gas emissions in other countries.
These projects generate tradable carbon
credits that can be used by Annex I countries in meeting their
caps. The project-based Kyoto Mechanisms are the Clean Development Mechanism
(CDM) and Joint Implementation (JI).
The CDM covers projects taking place in non-Annex I
countries, while JI covers projects taking place in Annex I countries. CDM
projects are supposed to contribute to sustainable development in
developing countries, and also generate "real" and
"additional" emission savings, i.e., savings that only occur thanks
to the CDM project in question (Carbon Trust, 2009, p. 14). Whether or not
these emission savings are genuine is, however, difficult to prove (World Bank,
2010, pp. 265–267).
Australia
Main articles: Garnaut Climate Change Review,
Carbon Pollution Reduction Scheme
and Clean Energy Bill 2011
In 2003 the New South Wales (NSW) state government
unilaterally established the NSW Greenhouse Gas Abatement Scheme to reduce
emissions by requiring electricity generators and large consumers to purchase
NSW Greenhouse Abatement Certificates (NGACs). This has prompted the rollout of
free energy-efficient compact fluorescent lightbulbs and other
energy-efficiency measures, funded by the credits. This scheme has been
criticised by the Centre for Energy and Environmental Markets (CEEM) of the UNSW
because of its lack of effectiveness in reducing emissions, its lack of
transparency and its lack of verification of the additionality of emission
reductions.
Both the incumbent Howard
Coalition government and the Rudd
Labor opposition promised to
implement an emissions trading scheme (ETS) before the 2007 federal election.
Labor won the election, with the new government proceeding to implement an ETS.
The government introduced the Carbon Pollution Reduction Scheme,
which the Liberals supported with Malcolm
Turnbull as leader. Tony Abbott
questioned an ETS, saying the best way to reduce emissions is with a
"simple tax". Shortly before the carbon vote, Abbott defeated
Turnbull in a leadership challenge, and from there on the Liberals opposed the
ETS. This left the government unable to secure passage of the bill and it was
subsequently withdrawn.
Julia Gillard defeated Rudd in a
leadership challenge and promised not to introduce a carbon tax, but would look
to legislate a price on carbon when
taking the government to the 2010 election. In
the first hung parliament result in 70 years,
the government required the support of crossbenchers including the Greens.
One requirement for Greens support was a carbon price, which Gillard proceeded
with in forming a minority government. A fixed carbon price would proceed to a
floating-price ETS within a few years under the plan. The fixed price leant
itself to characterisation as a carbon tax and when the government proposed the
Clean Energy Bill in February
2011, the opposition claimed it to be a broken election promise.
The bill was passed by the Lower House in
October 2011 and the Upper
House in November 2011. The Liberal Party vowed to overturn the
bill if elected.
The Liberal/National coalition
government elected in September 2013 has promised to reverse the climate
legislation of the previous government. In July 2014, the carbon tax was
repealed.
New Zealand
The New Zealand Emissions Trading Scheme (NZ ETS) is a
partial-coverage all-free allocation uncapped highly internationally linked
emissions trading scheme. The NZ ETS was first legislated in the Climate
Change Response (Emissions Trading) Amendment Act 2008 in
September 2008 under the Fifth Labour Government of
New Zealand and then amended in November 2009 and in November
2012 by the Fifth National Government
of New Zealand.
The NZ ETS covers forestry (a net sink), energy (43.4%
of total 2010 emissions), industry (6.7% of total 2010 emissions) and waste
(2.8% of total 2010 emissions) but not pastoral agriculture (47% of 2010 total
emissions). Participants in the NZ ETS must surrender one emission unit (either
an international 'Kyoto' unit or a New Zealand-issued unit) for every two
tonnes of carbon dioxide equivalent emissions reported or they may choose to
buy NZ units from the government at a fixed price of NZ$25.
Individual sectors of the economy have different entry
dates when their obligations to report emissions and surrender emission units
take effect. Forestry, which contributed net removals of 17.5 Mts
of CO2e in 2010 (19%
of NZ's 2008 emissions,) entered the NZ ETS on 1 January 2008. The stationary
energy, industrial processes and liquid fossil fuel sectors entered the NZ ETS
on 1 July 2010. The waste sector (landfill operators) will enter on 1 January
2013. Methane and nitrous oxide emissions from pastoral agriculture are not
included in the NZ ETS. (From November 2009, agriculture was to enter the NZ
ETS on 1 January 2015)
The NZ ETS is highly linked to international carbon
markets as it allows the importing of most of the Kyoto
Protocol emission units. It also creates a specific domestic
unit; the 'New Zealand Unit' (NZU), which will be issued by free allocation to
emitters, with no auctions intended in the short term. Free allocation of NZUs
will vary by sector. The commercial fishery sector (who are not participants)
will receive a free allocation of units on a historic basis. Owners of pre-1990
forests will receive a fixed free allocation of units. Free allocation to
emissions-intensive industry, will be provided on an output-intensity basis.
For this sector, there is no set limit on the number of units that may be
allocated. The number of units allocated to eligible emitters will be based on
the average emissions per unit of output within a defined 'activity'. Bertram
and Terry (2010, p 16) state that as the NZ ETS does not 'cap' emissions, the
NZ ETS is not a cap and trade scheme as understood in the economics literature.
Some stakeholders have criticized the New Zealand
Emissions Trading Scheme for its generous free allocations of emission units
and the lack of a carbon price signal (the Parliamentary
Commissioner for the Environment), and for being ineffective in
reducing emissions (Greenpeace Aotearoa New Zealand).
The NZ ETS was reviewed in late 2011 by an independent
panel, which reported to the public in September 2011.
European Union
The European Union Emission Trading Scheme (or EU ETS)
is the largest multi-national, greenhouse gas emissions trading scheme in the
world. It is one of the EU's central policy instruments to meet their cap set
in the Kyoto Protocol (Jones et al.., 2007, p. 64).
After voluntary trials in the UK and
Denmark, Phase I commenced operation in January 2005 with all 15 member states
of the European Union participating. The
program caps the amount of carbon dioxide that can be emitted from large
installations with a net heat supply in excess of 20 MW, such as power plants
and carbon intensive factories and covers almost half (46%) of the EU's
Carbon Dioxide emissions. Phase I permits participants to trade amongst
themselves and in validated credits from the developing world through Kyoto's Clean Development Mechanism.
During Phases I and II, allowances for emissions have
typically been given free to firms, which has resulted in them getting windfall
profits (CCC, 2008, p. 149). Ellerman and Buchner (2008) (referenced by
Grubb et al.., 2009, p. 11) suggested that during its first two
years in operation, the EU ETS turned an expected increase in emissions
of 1-2 percent per year into a small absolute decline.[92]
Grubb et al.. (2009, p. 11) suggested that a reasonable estimate
for the emissions cut achieved during its first two years of operation was
50-100 MtCO2 per year, or 2.5-5 percent.
A number of design flaws have limited the
effectiveness of scheme (Jones et al.., 2007, p. 64). In the
initial 2005-07 period, emission caps were not tight enough to drive a
significant reduction in emissions (CCC, 2008, p. 149). The total
allocation of allowances turned out to exceed actual emissions. This drove the
carbon price down to zero in 2007. This oversupply was caused because the
allocation of allowances by the EU was based on emissions data from the
European Environmental Agency in Copenhagen, which uses a horizontal activity
based emissions definition similar to the United Nations, the EU ETS
Transaction log in Brussels however uses a vertical installation based
emissions measurement system. This caused an oversupply of 200 million tonnes
(10% of market) in the EU ETS in the first phase and collapsing prices.
Phase II saw some tightening, but the use of JI and
CDM offsets was allowed, with the result that no reductions in the EU will be
required to meet the Phase II cap (CCC, 2008, pp. 145, 149). For
Phase II, the cap is expected to result in an emissions reduction in 2010 of
about 2.4% compared to expected emissions without the cap (business-as-usual
emissions) (Jones et al.., 2007, p. 64). For Phase III (2013–20),
the European Commission has proposed a
number of changes, including:
- the setting of an overall EU cap, with allowances then allocated to EU members;
- tighter limits on the use of offsets;
- unlimited banking of allowances between Phases II and III;
- and a move from allowances to auctioning.
In January 2008, Norway, Iceland, and Liechtenstein
joined the European Union Emissions Trading System (EU ETS),
according to a publication from the European Commission. The Norwegian Ministry of the
Environment has also released its draft National Allocation Plan
which provides a carbon cap-and-trade
of 15 million metric tonnes of CO2, 8 million of which are set to be
auctioned. According
to the OECD Economic Survey of Norway 2010, the nation "has announced a
target for 2008-12 10% below its commitment under the Kyoto Protocol and a 30%
cut compared with 1990 by 2020."
Tokyo, Japan
The Japanese city of Tokyo is like a country in its
own right in terms of its energy consumption and GDP. Tokyo consumes as much
energy as "entire countries in Northern Europe, and its production matches
the GNP of the world's 16th largest country". Originally, Japan had a
voluntary emissions reductions system that had been in place for some years,
but was not effective. Japan has its own emission reduction policy but not a
nationwide cap and trade program. This climate strategy is enforced and
overseen by the Tokyo Metropolitan Government (TMG). The first phase, which is
alike to Japan's scheme, runs up to 2015, these organizations will have to cut
their carbon emissions by 6% or 8% (depending on the type of organization);
those who fail to operate within their emission caps will from 2011 on be
required to purchase emission allowances to cover any excess emissions, or
alternatively, invest in renewable energy certificates or offset credits issued
by smaller businesses or branch offices. Firms whom fail to comply will face
fines of up to 500,000 yen plus an amount of credits to equal the emissions 1.3
times the amount they failed to reduce during the first phase of the scheme.The
long term aim is to cut the metropolis' carbon emissions by 25% from 2000
levels by 2020.
United States
An early example of an emission trading system has
been the SO2 trading system under the framework of the Acid
Rain Program of the 1990 Clean Air Act in the U.S. Under
the program, which is essentially a cap-and-trade emissions trading system, SO2
emissions were reduced by 50% from 1980 levels by 2007. Some experts argue that
the cap-and-trade system of SO2 emissions reduction has reduced the
cost of controlling acid rain by as much as 80% versus source-by-source
reduction. The SO2 program was challenged in 2004,
which set in motion a series of events that led to the 2011 Cross-State Air Pollution Rule
(CSAPR). Under the CSAPR, the national SO2 trading program with four
separate trading groups for SO2 and NOx.
In 1997, the State of Illinois
adopted a trading program for volatile organic compounds
in most of the Chicago area, called the Emissions Reduction Market System.
Beginning in 2000, over 100 major sources of pollution in eight Illinois
counties began trading pollution credits.
In 2003, New York State
proposed and attained commitments from nine Northeast states to form a
cap-and-trade carbon dioxide emissions program for
power generators, called the Regional Greenhouse Gas
Initiative (RGGI). This program launched on January 1, 2009 with
the aim to reduce the carbon "budget" of each state's electricity
generation sector to 10% below their 2009 allowances by 2018.
Also in 2003, U.S. corporations were able to trade CO2
emission allowances on the Chicago Climate Exchange
under a voluntary scheme. In August 2007, the Exchange announced a mechanism to
create emission offsets for projects within the
United States that cleanly destroy ozone-depleting
substances.
Also in 2003, the Environmental Protection Agency
(EPA) began to administer the NOx Budget Trading Program (NBP)under the NOx
State Implementation Plan (also known as the "NOx SIP Call") The NOx
Budget Trading Program was a market-based cap and trade program created to
reduce emissions of nitrogen oxides (NOx) from power plants and
other large combustion sources in the eastern United States. NOx is
a prime ingredient in the formation of ground-level ozone (smog), a pervasive
air pollution problem in many areas of the eastern United States. The NBP was
designed to reduce NOx emissions during the warm summer months,
referred to as the ozone season, when ground-level ozone concentrations are
highest. In March 2008, EPA again strengthened the 8-hour ozone standard to
0.075 parts per million (ppm) from its previous 0.008 ppm.
In 2006, the California Legislature passed
the California Global Warming Solutions Act, AB-32,
which was signed into law by Governor Arnold Schwarzenegger. Thus far,
flexible mechanisms in the form of project based offsets have been suggested
for three main project types. The project types include: manure
management, forestry, and destruction of ozone-depleted
substances. However, a recent ruling from Judge Ernest H. Goldsmith of San
Francisco's Superior Court states that the rules governing California's
cap-and-trade system were adopted without a proper analysis of alternative
methods to reduce greenhouse gas emissions. The tentative ruling, issued on
January 24, 2011, argues that the California Air Resources Board
violated state environmental law by failing to consider such alternatives. If
the decision is made final, the state would not be allowed to implement its
proposed cap-and-trade system until the California Air Resources Board fully
complies with the California Environmental
Quality Act.
In February 2007, five U.S. states and four Canadian
provinces joined together to create the Western Climate Initiative
(WCI), a regional greenhouse gas emissions trading system. In July 2010, a
meeting took place to further outline the cap-and-trade system. In November
2011, Arizona, Montana, New Mexico, Oregon, Utah and Washington withdrew from
the WCI.
On November 17, 2008 President-elect Barack
Obama clarified, in a talk recorded for YouTube,
his intentions for the US to enter a cap-and-trade system to limit global
warming.
The 2010 United States federal budget
proposes to support clean energy development with a 10-year investment of US
$15 billion per year, generated from the sale of greenhouse gas (GHG) emissions
credits. Under the proposed cap-and-trade program, all GHG emissions credits
would be auctioned off, generating an estimated $78.7 billion in additional
revenue in FY 2012, steadily increasing to $83 billion by FY 2019.
The American Clean Energy and
Security Act (H.R. 2454), a greenhouse gas cap-and-trade bill,
was passed on June 26, 2009, in the House of Representatives by a vote of
219-212. The bill originated in the House Energy and Commerce Committee and was
introduced by Representatives Henry A. Waxman and Edward J. Markey. Although
cap and trade also gained a significant foothold in the Senate via the efforts
of Republican Lindsey Graham, Independent Democrat Joe
Lieberman, and Democrat John Kerry,
the Legislation died in the Senate.
Renewable energy certificates
Renewable Energy Certificates
(occasionally referred to as or "green tags" [citation required]),
are a largely unrelated form of market-based instruments that are used to
achieve renewable energy targets, which may be environmentally motivated (like
emissions reduction targets), but may also be motivated by other aims, such as
energy security or industrial policy.
Carbon market
Carbon emissions trading is emissions trading
specifically for carbon dioxide (calculated in tonnes of
carbon dioxide equivalent or
tCO2e) and currently makes up the bulk of emissions trading. It is
one of the ways countries can meet their obligations under the Kyoto
Protocol to reduce carbon emissions and thereby mitigate global warming.
Market trend
Carbon emissions trading declined in 2013, and is
expected to decline in 2014.
According to the World Bank's
Carbon Finance Unit, 374 million metric tonnes of carbon dioxide equivalent
(tCO2e) were exchanged through projects in 2005, a 240% increase
relative to 2004 (110 mtCO2e) which was itself a 41% increase
relative to 2003 (78 mtCO2e).
Global carbon markets have shrunk in value by 60%
since 2011, but are expected to rise again in 2014.
In terms of dollars, the World Bank has estimated that
the size of the carbon market was 11 billion USD in 2005, 30 billion USD in
2006, and 64 billion in 2007.
The Marrakesh Accords of the Kyoto protocol defined
the international trading mechanisms and registries needed to support trading
between countries, with allowance trading now occurring between European
countries and Asian countries. However, while the USA as a nation did not
ratify the Protocol, many of its states are now developing cap-and-trade
systems and are looking at ways to link their emissions trading systems
together, nationally and internationally, to seek out the lowest costs and
improve liquidity of the market. However, these states also wish to preserve
their individual integrity and unique features. For example, in contrast to the
other Kyoto-compliant systems, some states propose other types of greenhouse
gas sources, different measurement methods, setting a maximum on the price of
allowances, or restricting access to CDM projects. Creating instruments that
are not truly fungible would introduce instability and
make pricing difficult. Various proposals are being investigated to see how
these systems might be linked across markets, with the International Carbon Action
Partnership (ICAP) as an international body to help co-ordinate
this.
Business reaction
In 2008, Barclays Capital predicted that the new carbon
market would be worth $70 billion worldwide that year. The voluntary offset
market, by comparison, is projected to grow to about $4bn by 2010.
23 multinational corporations
came together in the G8 Climate Change Roundtable,
a business group formed at the January 2005 World Economic Forum. The group
included Ford, Toyota,
British Airways, BP and Unilever.
On June 9, 2005 the Group published a statement stating that there was a need
to act on climate change and stressing the importance of market-based
solutions. It called on governments to establish "clear, transparent, and
consistent price signals" through "creation of a long-term policy
framework" that would include all major producers of greenhouse gases. By
December 2007 this had grown to encompass 150 global businesses.
Business in the UK have come out strongly in support
of emissions trading as a key tool to mitigate climate change, supported by
NGOs. However, not all businesses favor a trading approach. On December 11,
2008, Rex Tillerson, the CEO of Exxonmobil,
said a carbon tax is "a more direct, more
transparent and more effective approach" than a cap-and-trade program,
which he said, "inevitably introduces unnecessary cost and
complexity". He also said that he hoped that the revenues from a carbon
tax would be used to lower other taxes so as to be revenue neutral.
The International Air Transport
Association, whose 230 member airlines comprise 93% of all
international traffic, position is that trading should be based on
"benchmarking", setting emissions levels based on industry averages,
rather than "grandfathering", which would use
individual companies’ previous emissions levels to set their future permit
allowances. They argue grandfathering "would penalise airlines that took
early action to modernise their fleets, while a benchmarking approach, if
designed properly, would reward more efficient operations".
Measuring, reporting, verification (MRV)
An emissions trading system requires measurements at
the level of operator or installation. These measurements are then reported to
a regulator. For greenhouse gases all trading countries maintain an inventory
of emissions at national and installation level; in addition, the trading
groups within North America maintain inventories at the state level through The Climate Registry. For trading
between regions these inventories must be consistent, with equivalent units and
measurement techniques.
In some industrial processes emissions can be
physically measured by inserting sensors and flowmeters in chimneys and stacks,
but many types of activity rely on theoretical calculations for measurement.
Depending on local legislation, these measurements may require additional
checks and verification by government or third party auditors,
prior or post submission to the local regulator.
Enforcement
Another significant, yet troublesome aspect is enforcement.
Without effective MRV and enforcement the value of allowances is diminished.
Enforcement can be done using several means, including fines
or sanctioning those that have exceeded
their allowances. Concerns include the cost of MRV and enforcement and the risk
that facilities may be tempted to mislead rather than make real reductions or
make up their shortfall by purchasing allowances or offsets from another
entity. The net effect of a corrupt reporting system or poorly managed or
financed regulator may be a discount on emission costs, and a (hidden) increase
in actual emissions.
According to Nordhaus (2007, p. 27), strict
enforcement of the Kyoto Protocol is likely to be observed in those countries
and industries covered by the EU ETS. Ellerman and Buchner (2007, p. 71)
commented on the European Commission's (EC's) role in enforcing scarcity of
permits within the EU ETS. This was done by the EC's reviewing the total number
of permits that member states proposed that their industries be allocated.
Based on institutional and enforcement considerations, Kruger et al.
(2007, pp. 130–131) suggested that emissions trading within developing
countries might not be a realistic goal in the near-term.Burniaux et al..
(2008, p. 56) argued that due to the difficulty in enforcing international
rules against sovereign states, development of the carbon market would require
negotiation and consensus-building.
Criticism
Chicago Climate Justice activists protesting cap and
trade legislation in front of Chicago Climate Exchange building
in Chicago Loop
Emissions trading has been criticised for a variety of
reasons.
In the popular
science magazine New
Scientist, Lohmann (2006) argued that trading pollution
allowances should be avoided as a climate change policy. Lohmann gave several
reasons for this view. First, global warming will require more radical change
than the modest changes driven by previous pollution trading schemes such as
the US SO2 market. Global warming requires "nothing less than a
reorganisation of society and technology that will leave most remaining fossil
fuels safely underground." Carbon trading schemes have tended to reward
the heaviest polluters with 'windfall profits' when they are granted enough
carbon credits to match historic production. Carbon trading encourages
business-as-usual as expensive long-term structural changes will not be made if
there is a cheaper source of carbon credits. Cheap "offset" carbon
credits are frequently available from the less developed countries, where they
may be generated by local polluters at the expense of local communities.
Lohmann (2006b) supported conventional regulation,
green taxes, and energy policies that are "justice-based" and
"community-driven." According to Carbon Trade Watch (2009), carbon
trading has had a "disastrous track record." The effectiveness of the
EU ETS was criticized, and it was argued that the CDM had routinely favoured
"environmentally ineffective and socially unjust projects."
Annie Leonard provided a critical view
on carbon emissions trading in her 2009 documentary The Story of Cap and
Trade. This documentary emphasized three factors: unjust financial
advantages to major pollutors resulting from free permits, an ineffectiveness
of the system caused by cheating in connection with carbon
offsets and a distraction from the search for other solutions.
Offsets
Forest campaigner Jutta Kill (2006) of European environmental
group FERN
argued that offsets for emission reductions were not substitute for actual cuts
in emissions. Kill stated that "[carbon] in trees is temporary: Trees can
easily release carbon into the atmosphere through fire, disease, climatic
changes, natural decay and timber harvesting."
Supply of permits
Regulatory agencies run the risk of issuing too many
emission credits, which can result in a very low price on emission permits
(CCC, 2008, p. 140). This reduces the incentive that permit-liable firms
have to cut back their emissions. On the other hand, issuing too few permits
can result in an excessively high permit price (Hepburn, 2006, p. 239).
This is one of the arguments in favour of a hybrid instrument, that has a
price-floor, i.e., a minimum permit price, and a price-ceiling, i.e., a limit
on the permit price. A price-ceiling (safety value) does, however, remove the
certainty of a particular quantity limit of emissions (Bashmakov et al..,
2001).
Incentives
Emissions trading can result in perverse incentives. If, for
example, polluting firms are given emission permits for free
("grandfathering"), this may create a reason for them not to cut
their emissions. This is because a firm making large cuts in emissions would
then potentially be granted fewer emission permits in the future (IMF, 2008,
pp. 25–26). This perverse incentive can be alleviated if permits are
auctioned, i.e., sold to polluters, rather than giving them the permits for
free (Hepburn, 2006, pp. 236–237).
On the other hand, allocating permits can be used as a
measure to protect domestic firms who are internationally exposed to
competition (p. 237). This happens when domestic firms compete against
other firms that are not subject to the same regulation. This argument in
favour of allocation of permits has been used in the EU ETS, where industries
that have been judged to be internationally exposed, e.g., cement and steel
production, have been given permits for free (4CMR, 2008).
Auctioning
The revenues from auctioning go to the government.
These revenues could, for example, be used for research and development of
sustainable technology. Alternatively, revenues could be used to cut distortionary taxes, thus
improving the efficiency of the overall cap policy (Fisher et al..,
1996, p. 417).
Distributional effects
The Congressional Budget Office
(CBO, 2009) examined the potential effects of the American Clean Energy and
Security Act on US households. This Act relies heavily on the
free allocation of permits. The Bill was found to protect low-income consumers,
but it was recommended that the Bill be changed to be more efficient. It was
suggested that the Bill be changed to reduce welfare provisions for
corporations, and more resources be made available for consumer relief.
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